In other words, to the extent you have capital losses, there’s no need to hang onto winner shares for at least a year and a day in order to pay a lower tax rate. Unfortunately when you sell ETFs for short-term gains, you must pay your regular federal tax rate, which can be as high as 39.6% (or 43.4% if the 3.8% net investment income tax applies). Under a special unfavorable rule, even long-term gains from precious metal ETFs can be taxed at up to 28% (plus another 3.8% if the net investment income tax applies), because the gains are considered collectibles gains. Thankfully, there is a way to play the market in a short-term fashion while paying a lower tax rate on your gains: consider trading in broad-based stock index options. Favorable tax rates on short-term gains from broad-based index options Our beloved Internal Revenue Code treats broad-based stock index options, which look and feel a lot like options to buy and sell comparable ETFs, as Section 1256 contracts. The tax-saving result is that short-term profits from trading in broad-based stock index options are taxed at a maximum effective federal rate of only 27.84% [(60% × 20%) + (40% × 39.6%) = 27.84%], or 31.64% if the 3.8% net investment income tax applies. If you’re in the top 39.6% bracket, that’s a 29.7% reduction in your tax bill (ignoring the possible impact of the net investment income tax). The effective rate on short-term gains from trading in broad-based stock index options is only 19% [(60% × 15%) + (40% × 25%) = 19%]. Favorable treatment for losses too If you suffer a net loss from trading in Section 1256 contracts, including losses from broad-based stock index options, you can choose to carry back the net loss for three years to offset net gains from Section 1256 contracts recognized in those earlier years, including gains from broad-based stock index options. Finding broad-based stock index options A fair number of options meet the tax-law definition of broad-based stock index options, which means they qualify for the favorable 60/40 tax treatment.
There are two main drivers of asset class returns-inflation and growth. — Ray Dalio
Ray Dalio should know something about investment returns, as he started the Bridgewater investment company in a small apartment in 1975, and Bridgewater now encompasses the world’s largest hedge fund, worth many billions. Unlike Dalio, many investors underappreciate the role of inflation in their investments and how it has a negative impact on purchasing power. It’s especially harmful to those living on a fixed income in retirement.
Here’s a closer look at inflation and its role in your financial life and retirement.
Incredible shrinking purchasing power
Most of us are familiar with the way that prices for all kinds of things tend to go up over time. Maybe you remember buying a nice new car for $10,000 years ago while a similarly nice new car today might sell for $20,000. If you expect to travel in 25 years, know that a plane ticket that costs $400 today could cost $800 or more in 25 years. That’s inflation.
Inflation can be measured in various ways, and the most common measure of it is the “urban” (i.e. non-farmer, non-military, non-institutionalized) Consumer Price Index (CPI), which measures, year by year, the cost of a basket of common goods and services we Americans purchase. Those goods and services include food, clothing, housing, medical care, energy, and so on.
As prices for things rise, it challenges a fixed income — which is, in part, at least, what many people live on in retirement. Social Security benefits are adjusted to account for inflation, but many annuity payments and other payments are not. If you receive, say, $4,000 per month and your monthly expenses are just about that, you’ll be in trouble when property taxes, insurance premiums, food, utilities, gas, clothing, medical bills, Internet service, and many other expenses rise in price over time.
Inflation: nominal vs. real returns
Over long periods, inflation has averaged about 3% per year, but in any given year or period, it can be much higher or lower than that. In 2015, for example, it averaged close to 0%, while it was 6% in 1982, 9% in 1975, and more than 13% in 1980.
When it comes to investing, and to estimating how much money we’ll have in the future, it’s common to overlook inflation and its effects. When you read, for example, that the stock market has averaged annual returns of close to 10% over many decades, that’s not including inflation. That’s what’s called a “nominal” return, as opposed to a “real” return, which does incorporate inflation.
Check out the following data from Wharton Business School professor Jeremy Siegel, who has calculated the average returns for stocks, bonds, bills, gold, and the dollar, between 1802 and 2012 — yes, more than 200 years! He offers his results in both nominal and real terms: